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Posted by Jim McClaflin, EA, NTPI Fellow, CTRC

Understanding Universal Life Insurance & Its Tax Implications

Understanding Universal Life Insurance & Its Tax Implications

In life insurance, universal life insurance stands out as a versatile and flexible policy that provides both a death benefit and a cash value component. Unlike term life insurance, which offers coverage for a specified period, universal life insurance offers lifelong protection. Moreover, universal life insurance has unique tax advantages, making it an appealing option for many individuals. This article will explore how universal life insurance works and delve into its tax-related aspects.

Understanding Universal Life Insurance

Universal life insurance is a type of permanent life insurance that combines a death benefit with a cash value component. It is designed to provide lifelong coverage, meaning it does not have a specific term limit. This feature makes universal life insurance suitable for individuals who wish to protect their loved ones financially in the event of their death, regardless of when that may occur.

Flexible Premiums and Death Benefit

One of the key features of universal life insurance is the flexibility it offers in terms of premiums and death benefits. Policyholders have the ability to adjust both the amount and timing of premium payments as well as the death benefit amount, within certain limits set by the insurance company.

Cash Value Component

Universal life insurance policies accumulate cash value over time, which can be accessed by the policyholder. A portion of the premium payments goes towards the cost of insurance, while the insurance company invests the remaining amount. The invested funds grow tax-deferred within the policy, meaning that policyholders do not have to pay taxes on the investment gains as long as they remain within the policy.

Policy Loans and Withdrawals

One advantage of universal life insurance is accessing accumulated cash value through policy loans or withdrawals. Policyholders can borrow against their policy's cash value, much like a loan from a financial institution. The borrowed amount accrues interest, and if not repaid, it is deducted from the death benefit upon the insured's passing. Withdrawals, on the other hand, allow policyholders to access a portion of the cash value without incurring interest or affecting the death benefit.

Tax Advantages of Universal Life Insurance

Universal life insurance offers several tax advantages that can benefit policyholders in different ways:

  • Tax-Deferred Growth: The cash value component of a universal life insurance policy grows on a tax-deferred basis. This means that policyholders do not have to pay taxes on the investment gains as long as the funds remain within the policy. This allows the cash value to accumulate and compound over time, potentially resulting in substantial growth.

  • Tax-Free Death Benefit: The death benefit received by the policy's beneficiaries is typically tax-free. This means that the proceeds are not subject to income tax and can be received in full, providing financial security for the insured's loved ones.

  • Tax-Free Policy Loans and Withdrawals: Policy loans and withdrawals from the cash value of a universal life insurance policy are generally tax-free up to the total amount of premiums paid. Since premiums are typically made with after-tax dollars, the policyholder is not subject to additional income tax when accessing the cash value through loans or withdrawals.

  • Estate Tax Planning: Universal life insurance can also be an effective tool for estate tax planning. The death benefit can be used to provide liquidity to cover estate taxes, ensuring that heirs do not have to sell assets to meet their tax obligations. Additionally, if the policy is owned by an irrevocable life insurance trust (ILIT), the death benefit can be excluded from the insured's estate, potentially reducing estate taxes.

Considerations and Limitations

While universal life insurance offers several tax advantages, it is essential to consider certain factors before purchasing a policy:

  • Premium Payments: Universal life insurance requires ongoing premium payments to maintain the policy. If premium payments are not made as scheduled, the policy may lapse, and coverage may be lost.

  • Policy Expenses: Universal life insurance policies typically come with various fees and expenses, such as mortality charges and administrative costs. These expenses can reduce the overall cash value growth and should be carefully considered.

  • Interest Rates: The cash value growth of a universal life insurance policy is tied to the performance of the insurance company's investments. If interest rates are low, the cash value accumulation may be slower than anticipated.

  • Policy Flexibility: While universal life insurance provides flexibility in premium payments and death benefit adjustments, making significant changes can have implications on the policy's cash value and overall performance. It is crucial to understand the potential impact of any modifications before proceeding.


Universal life insurance is a versatile and flexible form of permanent life insurance that combines a death benefit with a cash value component. Its tax advantages, including tax-deferred growth, tax-free death benefit, and tax-free policy loans and withdrawals, make it an attractive option for many individuals. However, it is essential to carefully consider the policy's premiums, expenses, interest rates, and flexibility before making a decision. Consulting with a qualified insurance professional or financial advisor can provide valuable guidance tailored to individual circumstances.



Jim McClaflin, EA, NTPI Fellow, CTRC
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